The Greater Depression -- an Update

I recently shared some updated thoughts on the prospects for a Greater
Depression with readers of our International
Speculator newsletter. Given the increasing levels of volatility sweeping
global markets, I decided to give those thoughts a broader airing, below,
if for no other reason than to help those of you in a position to rig for
stormy weather get a sense of the gathering storm.

Hopefully, I'll be wrong about what's coming. But the way I
see it, being aware and prepared follows the same basic logic as personal
gun ownership: better to have one and not need it, than to need one and not
have it. You get the idea.

It's been said that if you spend 15 minutes a year thinking about the
economy, you're wasting 13 minutes. That's generally true. But
as an amateur historian, I can't help myself. And I'm forced to
believe that this is a time when the subject is worth some real thought.

My view is that the longest, and certainly most important, trend in history
is the ascent of man. I have little doubt that it will not only continue but
accelerate. But that doesn't mean there won't be nasty setbacks
along the way. As I have said before, possibly the best definition of a depression
is a period when most people's standard of living drops significantly.
You can also define it as a period when distortions in the economy and misallocations
of capital are liquidated. The distortions are almost always the result of
government intervention in the economy, through things like taxes, regulation
and currency inflation. Those are the factors that caused the unpleasantness
that began in 1929. Since the government is exponentially more powerful and
invasive today than it was in either the 1920s or the 1970s, I expect the consequences
will be much worse this time around. Things could have come unglued, and almost
did, back in the 1970s. I don't see how we'll dodge the bullet
this time. Although that's not really a good analogy, in that, for reasons
we don't have time to explore in depth, a depression is probably inevitable
this time.

The only serious question in my mind is whether it will be essentially deflationary
in nature, as it was the case in the U.S. in the 1930s, or inflationary like
in Germany in the 1920s. My guess is the latter because the government is so
much more powerful today. Or it could actually be both at once, in different
sectors of the economy.

How?

Inflation could drive interest rates to 20%. This would collapse the bond
and real estate markets, wiping out trillions of dollars of purchasing power
-- which is deflationary. Meanwhile, that same inflation doubles the cost of
food and fuel. In other words, the opposite of what we've mostly had
for the last generation, when we had "good" inflation in stocks,
bonds and property, but stable or dropping prices in "cost of living" items.
This time the pattern could reverse, which would be a nightmare for most people.

And as people become more focused on speculation in a generally futile attempt
to stay ahead of financial chaos, they inevitably divert effort from economic
production. Which will decrease the general standard of living even more.

The situation isn't made easier by the possibility that we're
facing Peak Oil -- the start of a secular decline in world oil production.
Or the fact that Americans, both individually and collectively, are deeply
in debt and living on the kindness of strangers. The problem with debt is that
it artificially increases our standard of living. But when we pay it off, especially
with interest, it reduces our standard of living in a very real way.

Wrap this economic environment around the so-called War on Terror, which
is rapidly morphing into the War on Islam, which could easily turn into World
War III, and you're looking at the perfect storm. The odds of a major
conflagration are very high, and it's not being adequately discounted.
If Bush starts a war against Iran, or if another incident like that of 9/11
occurs, or even if the trend of the last five years accelerates, the U.S. is
going to be locked down like one of its numerous new federal penitentiaries.
And that will be accompanied, and compounded, by mass hysteria among Boobus
americanus.

At that point, your investment portfolio will be among your lesser concerns.
People forget that, in every country and time, there's a standard distribution
of sociopaths and misdirected losers. In normal times, they seem like normal
people. But when the time is right, they show their colors, and they love to
get jobs with the government, where they can lord it over their betters.

Is the Greater Depression really inevitable? How bad will it be? Is
there another side to the argument? Can it be avoided?

I suppose it's not absolutely inevitable. Perhaps friendly aliens will
land on the roof of the White House and present the government with a magic
technology that can undo all the damage it's done. But we live in a world
of cause and effect where actions have consequences. That being the case, I
expect truly serious financial and economic trouble. And the government will
make it vastly worse by trying to "do something" instead of recognizing
itself as the cause and backing off. I don't see any way out.

How bad will it be? In historical terms, the last depression was relatively
short and mild. The longest depression on record was the Dark Ages. Residents
of the old USSR and Mao's China suffered through a depression that lasted
decades. I'm not predicting it will be that bad, if only because the
U.S. has basically much sounder traditions and institutions and vastly more
accumulated capital. But it's hard to overestimate how serious this could
be. I sometimes joke that it will likely be worse than even I think it will
be.

Getting back to whether it's truly inevitable, it's a question
of degree. The recession of the late 1970s and early 1980s involved a terrible
stock market, 15% inflation with interest rates to match, 10% unemployment
and a near war with the USSR. But the country not only hung together, it went
on to a tremendous rebound. My guess is, however, that the last 20 years of
good times will later be viewed as an economic Indian Summer before a harsh
winter.

The good news, of course, is that no matter what the economic conditions,
technology -- which is the mainspring of human progress -- will keep advancing.
And many individuals will continue innovating, saving and improving conditions
for themselves and their associates. Also, it's entirely possible to
go through even the worst of times and not get hurt. Indeed to profit from
them. If the price of a house you want now but can't afford falls 75%
(as outrageous as that may sound at the moment) while your own investments
in the high-quality gold stocks we follow in our International
Speculator quadruple, you're much better off. That house now
really only costs you one-sixteenth of what it did before. Of course it's
a problem for the guy who has to sell his house... but I always prefer
to look at the bright side of the equation. There's time now to structure
your affairs so that you're on the right side of the trade.

What indicators should we watch for that might tell us it's about
to get ugly?

Well, one obvious indicator is how the price of gold is running. Gold is
the only financial asset left in the world that's either safe or cheap.
It's also under owned and largely unrecognized, which is why the smart
money has been moving into it.

Then there's the CPI itself -- although I don't think it's
very accurate, in that all the adjustments, exclusions, weightings and what-nots
the government has insinuated into it over the years makes the CPI as much
of a floating abstraction as the dollar itself. It's funny how the government
plays with figures for fear of hurting confidence. They believe the economy
rests mainly on confidence, which, ironically, in today's world, is true.
Unfortunately, confidence can blow away like a pile of feathers in a windstorm
-- and we have a class-5 hurricane coming. If the economy were sound and people
for some reason lost confidence, the currency and the banks would be unhurt,
and the next day things would go back to normal. But that's not the world
we live in. So, higher CPI numbers are another thing that could destroy confidence
and supercharge the gold price. They're coming.

Higher interest rates, which we're already seeing, will inevitably
burst the real estate bubble, which is floating on a sea of mostly adjustable-rate
debt, a lot of it interest-only or even with negative amortization. Higher
rates will also crush bonds and probably stocks. And they'll devastate
the economy since everybody is deeply in debt. However, I feel the Fed will
keep short-term rates -- which are really the only ones they control -- as
low as possible for as long as possible. For one thing, they don't want
a recession, which this time could snowball into the Greater Depression. For
another, my guess is that they want to gradually depreciate the dollar against
other currencies, in part to decrease the chronic, massive trade deficit. And
because increasing the number of dollars makes people think they're richer
than they really are, it can stimulate some additional spending... but
these days that spending is mostly done on credit, so it is only illusionary.

The biggest single problem, however, is that there are trillions of U.S.
dollars outside of the U.S. Unlike Americans, foreigners have no reason to
hold them. And at some point very soon, perhaps when the Fed finally hits the
wall on its ability to raise rates, these overseas dollars are going to start
flooding back home, while the products and titles to real wealth flow out of
America.

Therefore, when the trade deficit starts turning around -- which most people
will think is a good thing -- that will be the real tip-off the game is over.
Trillions coming back to the U.S. will skyrocket long-term interest rates and
inflation. The dollar will go into freefall.

But although I think these are the things to watch, to my way of thinking
it makes no sense to wait until the stampede starts to try to get out the door.
If you haven't done so already, take advantage of the current correction
in gold to begin repositioning your portfolio for what's next.

Doug Casey is a highly respected author, publisher and professional investor
who graduated from Georgetown University in 1968.

Doug literally wrote the book on profiting from periods of economic turmoil:
his book Crisis Investing spent multiple weeks as #1 on the New York Times
bestseller list and became the best-selling financial book of 1980 with 438,640
copies sold; surpassing big-caliber names, like Free to Choose by Milton Friedman,
The Real War by Richard Nixon, and Cosmos by Carl Sagan.

Then Doug broke the record with his next book, Strategic Investing, by receiving
the largest advance ever paid for a financial book at the time. Interestingly
enough, Doug's book The International Man was the most sold book in the history
of Rhodesia.

He has been a featured guest on hundreds of radio and TV shows, including
David Letterman, Merv Griffin, Charlie Rose, Phil Donahue, Regis Philbin, Maury
Povich, NBC News and CNN; and has been the topic of numerous features in periodicals
such as Time, Forbes, People, and the Washington Post.

Doug, who divides his time between homes in Aspen, Colorado; Auckland, New
Zealand; and Salta, Argentina, has written newsletters and alert services for
sophisticated investors for over 28 years. Doug has lived in 10 countries and
visited over 175.

In addition to having served as a trustee on the Board of Governors of Washington
College and Northwoods University, Doug has been a director and advisor to
nine different financial corporations.

Doug is widely respected as one of the preeminent authorities on "rational
speculation," especially in the high-potential natural resource sector.

Information contained herein is obtained from sources believed to be reliable,
but its accuracy cannot be guaranteed. The information contained herein is
not intended to constitute individual investment advice and is not designed
to meet your personal financial situation. The opinions expressed herein are
those of the publisher and are subject to change without notice. The information
herein may become outdated and there is no obligation to update any such information.
Doug Casey, entities in which he has an interest, employees, officers, family,
and associates may from time to time have positions in the securities or commodities
covered in these publications. Corporate policies are in effect that attempt
to avoid potential conflicts of interest, and resolve conflicts of interest
that do arise in a timely fashion. No portion of this web site may be extracted
or reproduced without permission of the publisher.